# Actual Cash Value Coverage
Most insurance contracts contain a general loss provision limiting the reimbursement of the loss to "actual cash value." Often, these clauses do not specifically define the term.
An example of a **loss limitation** clause is as follows:
*This company shall not be liable beyond the actual cash value of the property at the time any loss or damage occurs, and the loss or damage shall be ascertained or estimated according to such actual cash value, with proper deduction for depreciation, however caused, and shall in no event exceed what it would then cost the insured to repair or replace the same with material of like kind and quality.*
Some states have enacted standard policy statutes that contain general loss definitions; however, they are generally subject to nearly unlimited interpretation because of their vagueness. A specific definition of actual cash value, however, is usually not found in the policy or the statute, except that sometimes the policy may mention that depreciation will be taken into account.
Courts have developed several methods of determining the actual cash value of insured property.
1\. Calculation of Actual Cash Value
"What constitutes actual cash value depends on the type of property, its condition at the time of the damage or loss, and the jurisdiction where the damage or loss occurs." \[1\]
Several tests have developed in various jurisdictions to determine this value, including fair market value, replacement cost, replacement cost minus depreciation, and broad evidence (any combination of the above factors and any other evidence available).
Market value is frequently used in determining the value of real or personal property. It is especially useful for those items where there is a ready market and value can be easily determined. The common definition of fair market value is the price a willing buyer would pay a willing seller. This value is determined as the difference between the fair market value before and after the loss.
For example, in a Nebraska case concerning the actual cash value of the damage to a motel, the Court determined actual cash value to mean "***the amount for which property may be sold by a willing seller who is not compelled to sell it to a buyer who is willing but not compelled to buy it…***." \[2\]
The jury should consider the condition of the property at the time of the loss and any other facts that would help establish the property's value. \[3\]
Another way the courts determine actual cash value is calculating the replacement cost to the insured. Many standard policies contain a provision limiting the liability of the insurer to the cost of repair or replacement. This provision is usually not considered a way to measure damages; however, some courts consider it in the calculation of actual loss.
For instance, in a partial loss situation, the Supreme Court of Kansas held that "*the term 'actual cash value', when applied to a partial loss under the insurance policy and facts in this case, means the cost to repair without any reduction for depreciation*." \[4\]
The Court rationalized that a reasonable insured would expect their losses to be covered and would not expect depreciation to affect their ability to repair or rebuild. In addition, the court concluded that depreciation was not contemplated by the parties when the contract was formed. Therefore, depreciation would not be considered in the calculation.
Most courts, however, when using replacement cost as a basis for determining actual value, take depreciation into account. This equation of replacement cost minus depreciation is yet another method used by courts to calculate actual cash value. This method is favored because it comes closer to reimbursing an insured for the actual loss.
In loss situations, an insured will normally repair or replace property with new materials. In most instances, this will increase the value of the property and if the insured were reimbursed the full amount of the repair costs, the insured would recognize a gain. Therefore, a reduction for depreciation is proper in calculating the actual cash value of the loss.
Finally, the modern trend in determining actual value is the "broad evidence rule" test. \[5\] "***Under this rule, the trier of fact may consider any evidence logically tending to the formation of a correct estimate of the value of the insured property at the time of loss.***" \[6\]
This broad rule would allow a jury to consider such items as market value, replacement cost, depreciation, age of the property, original cost, condition of the property, location, use, and possible profit. This method is seen as a fair way of calculating actual value. However, the criticism of the test is that it is too complex a method to employ to arrive at a reasonable calculation of loss.
Though there are other methods for determining actual cash value, the four methods discussed are by far the most prevalent. In most complex cases involving business property, more in-depth methods for calculating actual cash value are employed, such as the income approach and the divide-by-four approach that are beyond the scope of this paper.
B. Application to Total and Partial Loss
The various methods for determining actual cash value are each, at times, applied to both partial and total losses. Certain methods, however, are more applicable to one type of loss than another. Courts, therefore, often employ different methods for determining actual cash value for partial and total losses.
1\. Total Loss
When calculating the actual cash value of property that has been completely destroyed, the tests differ based on several factors, including jurisdiction and the type of property lost. Although there is no uniform test concerning total loss, each method will be discussed with specific examples provided.
#### a. Market Value
The market value test is most often used when the value of the property can be easily determined. In other words, it is more easily applied when there is an actual market for the property that was destroyed. If the loss was total, the trier of fact should determine the actual market value of the property at the time the loss occurs.
In certain types of cases, market value has been held to be the proper method of determining actual cash value. For example, when determining the value of general merchandise, machinery, and farm products, market value is often used because there is a ready market for these types of items and value can be easily determined. One must simply look to the marketplace to discover the value.
In contrast, market value is generally not accepted when determining the actual cash value of buildings, household furniture, and personal effects. As to buildings, one court stated that the rationale for rejecting market value was that "buildings, independently of the land upon which they stand, are never the subject of market sale." Thus, there is no available market to determine the value of the building when destroyed.
As to furniture and personal effects, most courts hold that it is well recognized that these items have no real market value on the open market. The correct measure of value for these items should be the amount of damage suffered by the owner due to their being deprived of the use of such property.
These general rules, however, are not dispositive on market valuation. There are reported decisions on both sides of the issue. For example, some courts hold that market value is the proper determination of actual cash value for buildings. Other cases hold that market value is not the appropriate measure of value for general merchandise. As stated earlier, there is no uniform measure across jurisdictions for any type of property.
#### b. Replacement Value
In the instances where market value was held to be an inadequate measure of actual cash value, courts often looked to replacement value as a guide. When using this method, the cost of depreciation is normally factored in. The courts considered the fact that replacing property without deducting depreciation, in most cases, would lead to a windfall for the insureds. Several factors are used when calculating replacement value and depreciation. Obvious considerations in determining the actual cash value include the age and condition of the property at the time of loss.
However, the courts often consider other factors. For example, in determining depreciation, obsolescence of the building, which is no longer suitable for its intended purpose at the time of loss, may be considered. Along the same lines, economically useless buildings may have no value at all. In an Illinois case, the court defined actual cash value for buildings as the cost of reproduction minus depreciation. However, the insured building that was destroyed by fire was economically useless at the time of the loss. Therefore, there was no insurable interest in the building and it had no value. Conversely, courts will often ignore other evidence. For example, the fact that the owner is going to demolish a building is a collateral matter and has no bearing on the actual cash value of the loss.
#### c. Broad Evidence Rule
Under the broad evidence rule, the court may consider any evidence that tends to assist in correctly estimating the value of the property at the time of the loss. This includes the market value calculation and the replacement value minus depreciation calculation. These two methods, however, are merely two of the standards and the court is not bound to them.
Several other factors have been determined applicable by the courts. In *Cardona v. Home Indem. Co.* \[7\], the New York appellate court held it was error to instruct the jury that the sole measure of actual cash value is reproduction costs minus depreciation. The trier of fact, the court determined, is allowed to consider the reproduction cost, original cost, the use the building may have been put to, qualified witness opinions on value, and any other fact that would shed light on the subject of value.
In a similar case, the Indiana appellate court held that when a fire policy limited the insurer's liability to the actual cash value at the time of loss, the trier of fact could take into account any evidence that established the economic value of the property. Items the court allowed to be considered included market value, reproduction cost and depreciation, obsolescence, income generated by the property, declarations against interest, and opinions of valuation experts.
The broad evidence rule, simply stated, allows the trier of fact to consider any reasonable measure of value to determine the actual cash value of property.
2\. Partial Loss
The actual cash value of partial losses is more difficult to determine than that of total losses. When an item is a total loss, it is easier to determine the market value or replacement value of the property. Often one must simply determine the price of a replacement good and use that as the actual cash value. With partial losses, however, it is difficult to determine what percentage of the property is damaged and how much it will cost to repair or replace.
#### a. Market Value
The market value of a partial loss is determined by calculating the difference between the fair market value of the property before and after the loss. This amount is normally limited to the cost of repair or replacement. Some courts have determined that the reasonable market value before and after the loss is the proper measure of actual cash value. Market value, however, appears to be the minority method of determining the actual cash value of partial losses. Courts seldom apply the market value test in partial loss situations because it is often difficult to calculate the market value of damaged property. This difficulty results from the nearly complete lack of market for damaged property, especially for property such as buildings and personal items. For this reason, one of the two following tests is generally applied to a partial loss.
#### b. Replacement or Repair Cost
Many jurisdictions hold that the appropriate measure of damages for a partial property loss is the reasonable cost of replacement or repair. The cost of the replacement or repair should be determined as of the date of loss. However, the insurer may be held responsible for any damage due to delay in payment. There is some division, however, on whether depreciation should be factored into the equation.
Some courts contend that a building should be restored to the same condition it was in before the loss and depreciation should not be considered. The rationale is that the insureds will be unable to complete repairs if depreciation is deducted from the amount awarded to them. The building would then remain unfinished and the insureds would not be indemnified as mandated by the policy.
Conversely, other courts hold that the proper method for determining the actual cash value of a partial loss is to calculate the amount it would take to put the property in the same condition as prior to the loss. These courts' definition of "same condition," however, differs from that above. The rationale here is that depreciation should be factored in to determine the actual value of the property at the time of loss. If the property is not depreciated, the insureds obtain increased value on their property over what it was at the time of the loss. This is due to the fact that new material used to repair or replace the property is more valuable than the older materials that were destroyed. A rebuilt building is normally more valuable than the building before the loss, if depreciation is not considered.
#### c. Broad Evidence Rule
In partial loss situations, courts frequently employ the broad evidence rule. Again, under this rule, the trier of fact may consider any evidence logically tending to aid in the determination of an accurate estimate of actual cash value. In a New Jersey case concerning an appraisal award for a partial fire loss, the court adopted the broad evidence rule. The court held that under this rule, both fair market value and replacement cost minus depreciation could be considered. A decision as to value could be based on either of these tests, both tests, or on any other evidence "an expert would consider relevant to an evaluation." The court went on to state the "\[t\]he wider the range of evidence considered by the fact-finder, the more reasonable it is for a court to accept his conclusions. A result reached under the broad evidence rule is more likely to be reliable than one based on either of the other standards alone."
D. Constructive Total Loss
When property is only partially damaged, it will be considered a total loss if a government ordinance or law prevents the insured from rebuilding or repairing the property. This is what is known as a "constructive total loss." Often, repairs to the building may be possible and even economically feasible; however, government action will render the building a total loss because of a prohibition against repair or rebuilding.
This situation may arise for various reasons. First, an ordinance may require a damaged building to be destroyed or removed for safety purposes. Second, a total loss may be found when the damaged building is condemned, even if the building was unsound when it was insured. Finally, a constructive total loss may be found when the cost to improve to new code regulations is greater than the value of the total loss.
The courts have used two basic principles to determine whether a total loss has occurred. First, a total loss is sustained when there is not a substantial remnant upon which a prudent uninsured person would rebuild.
In *Stahlberg v. Travelers Indemnity Co.* \[8\], the insured building was partially damaged by fire, and an order for demolition was issued per a local ordinance. The building was, therefore, a constructive total loss. The court stated a building is considered a total loss if the damage results in "no substantial remnant remaining that a prudent uninsured person would use in rebuilding." The insured suffered a total loss due to the demolition order and was to be indemnified as such.
The second method to determine total loss is the "loss of identity rule." In *Occhipinti v. Boston Ins. Co.*, the court stated that a "constructive total loss has occurred…when the building has been so damaged as to lose its identity." The court held that even when repairs could be made, if there was a possibility that future repairs would be called for, the insured should not assume this risk. In other words, if the structural integrity of the building is questionable, then a constructive total loss should be found because the insured should not be forced to assume the risk of hidden dangers.
Many insurance contracts provide for an exclusion attempting to limit liability from government regulations on repair and reconstruction, usually called an "ordinance or law exclusion." The typical exclusion states: "*We do not cover loss…resulting in any manner from…enforcement of any ordinance or law regulating the construction, reconstruction, maintenance, repair or demolition of buildings or other structures*."
There is a split of authority on whether these provisions are enforceable in determining the actual cash value of the loss. One of the first cases interpreting constructive total loss and an ordinance or law exclusion is *Hewins v. London Assurance Corp.*. In this case, twelve different insurers contended that building laws should not be considered in the valuation of damages. Only one of the insurers had an ordinance or law exclusion. The court held that a loss is total if an ordinance prevents the repair of the building, even if the cost to repair is less than the total loss. However, the exclusion of the one insurer was enforced and it was not liable for the increased cost due to the building ordinance.
In *Feinbloom v. Camden Fire Ins. Assn.*, a local ordinance required that the damaged building be brought up to code if it was repaired. The insurance policy on the building had an ordinance or law exclusion. The court held that if "by reason of public regulations rebuilding is prohibited the loss is total." The court went on to state that the policy exclusion simply stated that the insurer would not be responsible for the "increased cost of repair or reconstruction by reason of any ordinance." It does not limit liability for "loss caused by the operation of ordinance or law." In other words, because the loss is total in light of the ordinance, there is no increased cost of repair. "The court reasoned that where the loss was total, repairs are not permitted; therefore, there is nothing to which costs may be added."
There is, therefore, some question as to whether an ordinance or law exclusion limits liability of the insurer in cases of constructive total loss.
E. Replacement Cost Coverage
A. Introduction
The underlying purpose of property insurance is indemnity; however, insurers recognized that actual cash value payments for damaged and/or destroyed property did not fully restore insureds to their original financial position. Thus, insurers created replacement cost coverage that sought to insure not only the market value of the property, but also the expected depreciation of the property.
Generally, replacement cost provisions in first-party property insurance policies can be divided into three types:
1. The first is a valuation provision that attempts to restrict the insured's recovery of replacement cost to the smallest of several amounts. For example, the provision might restrict an insured to the lesser of the cost to replace the property with equivalent property, the amount actually spent for replacement property, or the policy liability limit applicable to the property.
2. The second gives the insured the option of foregoing replacement cost recovery and instead receiving payment of the actual cash value of the damaged property.
3. The third, which is the most controversial and most often litigated, requires the insured to actually repair or replace the damaged or destroyed property before being entitled to recover the full replacement cost.
A recent variation of replacement cost coverage, which raises scope of indemnity issues, is the "Guaranteed Replacement Cost" coverage endorsement. This optional coverage provides for replacement cost coverage above and beyond the policy limit subject to certain policy restrictions. A typical Guaranteed Replacement Cost endorsement might provide: "*We will settle covered loss to buildings under \[Coverages\] at replacement cost regardless of the limits of insurance shown on your Declarations Page, Subject to the following provisions...*"
The issue of the scope of indemnity pursuant to a guaranteed replacement cost endorsement was addressed in *Roberts v. Allied Group Ins. Co.*, 79 Wash. App. 323, 901 P.2d 317 (1995). In *Roberts*, the plaintiff had all-risk homeowners insurance with a guaranteed replacement cost endorsement. After the property was destroyed by fire, the plaintiff contended that they were entitled to recover the cost of a stepped foundation and a containment wall recommended by an engineer.
The court simply explained: "*Prior to the fire, the land did not have a containment wall and the house was built without the benefit of a stepped foundation… \[the improvements\] are not physically required for reconstruction. Nor did the fire in any way cause such soil stabilization measures to be more necessary than before the fire….these costs are not covered by the policy.*"
In holding there was no coverage for the cost of reconstruction of a dock under a guaranteed replacement cost endorsement because the policy's ordinance and law exclusion foreclosed recovery.
*Roberts* should not be interpreted to stand for the proposition that other courts would not permit insureds to recover for earth stabilization claims pursuant to a policy's replacement cost endorsements. In fact, California courts, in addressing the scope of coverage for land movement claims, have held that insurers are liable for the cost of stabilizing the soil under the insured's dwelling up to the limits of the policy when earth movement is an insured peril. Thus, in some jurisdictions, an insured who complies with the restrictions of the policy's guaranteed replacement cost coverage would be entitled to recover for a one million dollar earth stabilization claim even if the policy contained a $100,000 limit of liability.
Through a review of federal and state court decisions, this paper seeks to examine the issues raised by replacement cost coverage provisions, including:
1. the enforceability of the requirement of actual repair or replacement of damaged or destroyed property
2. the problem of partial losses
3. the enforceability of contractual time limitations on replacement
4. quality issues
5. location restrictions.
B. Requirement of Actual Repair or Replacement
1\. Holdbacks - Generally
The replacement cost coverage provision that requires an insured to repair or replace the damaged or destroyed property after a loss is commonly known in the industry as a "holdback." The term literally means that an insurer, after paying the actual cash value of the property, withholds or "holds back" an amount equal to the property's calculated depreciation until the property is actually repaired or replaced. Although the term "holdback" will not be found in an insurance policy, this valuation of loss concept is found in a variety of replacement cost coverage provisions.
For example, a standard replacement cost endorsement might contain the following provision: "*We will not pay on a replacement cost basis for any loss or damage: (1) Until the lost or damaged property is actually repaired or replaced…*"
The intent of this and similar "holdback" language is to prevent insureds, who do not replace damaged property, from realizing a profit on the depreciation of their property.
For example, an insured purchases homeowners insurance with replacement cost coverage on a twenty-year-old cottage that has an actual cash value of $20,000. Subsequently, the cottage is destroyed by fire and will now cost $43,000 to rebuild. If the insurer forwards a payment for the replacement value of the cottage and the insured elects not to rebuild, the insured will realize a profit of $23,000. Thus, there lies an inherent "moral hazard" in providing replacement cost coverage payments to insureds prior to the actual repair, reconstruction, or replacement of the covered property.
In response to this moral hazard, underwriters drafted policy language that attempts to minimize the temptation of the insured by imposing conditions precedent before full replacement costs can be recovered. Although the policy permits as an option the restoration of the insured to the same position enjoyed prior to the loss, it simultaneously precludes the insured from becoming unjustly enriched through the claim adjustment process.
Critics of holdback provisions argue that at the time of a loss, the insurer forces the insured between the proverbial rock and a hard place. Returning to our hypothetical case, the insured will not receive the holdback of $23,000 until that amount is expended on reconstruction costs. However, the insured may not have readily available funds or sufficient credit to finance a $23,000 reconstruction project. Thus, critics argue, holdback provisions place the insured in an unequal bargaining position that forces the financially weaker insured to accept lesser settlements of actual cash value as opposed to the substantially higher replacement cost value of the damaged property.
2\. Validity of Holdbacks - Replacement Required
The validity of holdbacks or, stated differently, the requirement of actual repair or replacement of damaged property after a loss, is the most litigated aspect of replacement cost coverage. To date, a majority of courts have upheld both the validity and enforceability of policy language that permits insurers to withhold partial disbursement of policy proceeds until actual replacement of the damaged property is complete.
For example, in *Hess v. North Pacific Ins. Co.*, 122 Wash. 2d 180, 859 P. 2d 586 (1993), the Supreme Court of Washington reversed the Court of Appeals and granted judgment in favor of the insurer, holding that a homeowner's insurance policy unambiguously limited coverage to actual cash value if the insured chose not to replace the structure.
The policy at issue contained the following provision: "*\[Insurer\] will pay no more than the actual cash value of the damage: unless (a) actual repair or replacement is complete.*"
Thus, the court concluded since the policy language was clear and unambiguous, the court would follow the majority rule enforcing the plain language of the policy. Numerous other courts have concluded that similar holdback provisions are valid and enforceable.
3\. Validity of Holdbacks - Actual Repair or Replacement not Required
Although courts have generally supported insurers' efforts to limit their liability for replacement cost coverage by requiring insureds to actually repair or replace the property, a growing minority of courts have permitted insureds to enjoy full recovery of replacement costs without complying with the condition precedent of the holdback provisions.
In most of these cases, courts will choose to ignore the policy language and will instead focus on the conduct of the insurer, the circumstances of the claim, or locate a suitable statutory or public policy consideration in order to create a rationale for the departure from the general rule.
A good example of this approach is *McCahill v. Commercial Union Ins. Co.*, 179 Mich. App. 761, 446 N.W.2d 579 (1989). In *McCahill*, Commercial Union insured the plaintiff's home and contents which were destroyed by fire. The insurer's representative engaged in questionable conduct during the investigation of the claim and a jury later decided that the insurer had wrongfully denied the plaintiff's claim. On appeal, the insurer argued that the insured could not recover replacement costs for his dwelling and contents as he failed to repair or replace his property. The court, while refusing to address the issue, did acknowledge the insurer's argument that the policy and Michigan legislation required that as a condition precedent to replacement cost recovery the insured must repair or replace the property. In spite of the plain language of the contract and statute, the court held that the insured was entitled to recover the full replacement value of his property without actually replacing the damaged property since Commercial Union's conduct—non-payment of the claim—hindered the insured's performance of the condition precedent.
*Bailey v. Farmer Union Co-operative Ins. Co. of Neb.* (1992) is another case where an insurer's conduct during the claim handling process ultimately resulted in an adverse interpretation of policy language. The underlying claim arose after the insured's home collapsed during a reconstruction project. Although the insurer knew that the insured's claim was covered under the policy and that the property was insured at replacement cost, its representative would only commit to an actual cash value settlement. Moreover, the insured was a chronically ill single mother with virtually no means of financial support. After settlement negotiations failed, the insured sued to recover the replacement cost of her home under the policy. The Nebraska Court of Appeals affirmed the trial court's finding that the "intransigence" of the insurer prevented the insured from complying with the policy's provision requiring reconstruction within 180 days of the loss. The *Bailey* court, highlighting the dilemma faced by financially challenged insureds, stated: "*Bailey could not proceed with the building as long as Farmers Union refused to commit itself to future reimbursement of Bailey for rebuilding costs. She did not have the money to initiate rebuilding on her own, and she would not have been able to secure a loan without the assurance by Farmers Union that additional replacement costs would be covered up to the policy limit.*"
More recently, an Oklahoma court, relying on public policy considerations, has gone a step further and vitiated a holdback provision contained in a replacement-cost endorsement of a homeowner's policy. In *Coblentz v. Oklahoma Farm Bureau Mutual Ins. Co.*, 915 P.2d 938 (1995), the court held that the replacement cost endorsement provision was void as unconscionable. In *Coblentz*, the insureds had lost all of their personal property in a tornado. The insurer paid the insureds $16,855, the actual cash value of their losses, but withheld approximately $10,000, arguing that the insureds had failed to comply with the policy's conditions precedent of actual repair or replacement of the damaged property. The *Coblentz* court found that the policy was unconscionable because (1) the insureds lacked a reasonable choice, and (2) the challenged provision unreasonably favored the insurer. Thus, it concluded the holdback provision was not enforceable because it violated public policy.
The court reasoned that the insurer, by forcing the insureds to replace their property, placed the insureds in a "legal Catch-22." To illustrate this point further, the court stated: "*This \[holdback\] provision is offensive for yet another reason. In order to obtain replacement value under the terms of the contract, Insurer requires \[insured\] to expend replacement funds without any assurances that they will be reimbursed. For instance, even if \[insured\] were to replace the property, Insurer might still deny payment contending the replacement property procured was not a similar item of like kind and quality as required by the policy or that the property was not covered by the terms of the policy.*"
Other courts have found "ambiguity" in the language of the holdback provision and, therefore, have determined the holdback provision is unenforceable. See, *Ballard v. Lee*, 671 So.2d 1368 (Ala. 1995) (replacement cost proceeds owed to insured before actual replacement because policy failed to define the term "actual cash value"); *Saves v. Safeco Ins. Co.*, 567 So.2d 687 (La. App. 1990).
At least one court has prevented insurers from withholding a specified percentage in all replacement cost coverage claims. In *Gilderman v. State Farm Ins. Co.*, 659 A.2d 941 (Pa. Super. 1994), the court ruled that an insurer may not automatically withhold a flat twenty percent of the repair or replacement costs of a covered loss, representing contractor overhead and profit, in calculating its advance payment to its insured of the actual cash value of the covered loss. In reversing the trial court's granting of summary judgment in favor of the insurer, the court reasoned that "the actual cost of repair or replacement" logically and necessarily includes any cost that an insured could be expected to incur in repairing or replacing a covered loss. Thus, the court concluded the insurer's automatic twenty percent holdback impermissibly benefited the insurer. It is clear from the above highlighted decisions that replacement cost holdback provisions are under increasing attack from a growing minority of courts.
C. Related Replacement Cost Valuation Problems: Partial Loss
Occasionally, the partial destruction of an insured's real or personal property raises interesting issues regarding replacement cost coverage. In *Kolls v. Aetna Casualty & Surety Co.*, 503 F.2d 569 (8th Cir. 1974), the court held (a) that under the terms of a replacement cost endorsement to a fire policy, the insureds were required to repair and replace the partially damaged structure and expend an amount in excess of actual cash value before they could recover under the endorsement; and (2) where the insureds expended, in repairing and replacing the partially damaged structure, less than the insurer had already paid on the claim for actual cash value, the insureds were not entitled to recover under the replacement cost endorsement. The *Kolls* and *Patrick* decisions are consistent with the majority rule with regard to holdbacks in that insureds are required to actually repair or replace the damaged property and are not entitled to a windfall recovery.
However, some courts view the issue of partial losses in a completely different light. For example, a Pennsylvania insurer's practice of deducting for depreciation for partial losses was successfully challenged by an actual cash value policyholder. In *London v. Insurance Placement Facility of Pennsylvania*, 1996 Pa. Super. LEXIS 1182 (Pa. Super. Ct., 1996); decision vacated; reversed and remanded, 1996 Pa. Super. LEXIS 3657, the Pennsylvania Superior Court upheld a lower court decision rejecting an insurer's deduction for depreciation on a partial fire loss. In *London*, the plaintiffs had suffered partial fire losses at their respective properties. The Insurance Placement Facility ("Facility") provided the plaintiffs with basic property insurance on an actual cash value basis as prescribed by statute. After the parties agreed on the repairs, the Facility deducted depreciation from the repair costs to arrive at the actual cash value of the partially damaged property. While acknowledging that a deduction for depreciation would be allowed in the case of a total loss, the court, placing reliance on *Fedas v. State Ins. Co. of Pa.*, 300 Pa. 555, 151 A.2d 285 (1930), concluded: "*To allow a deduction for depreciation for partial losses would often leave the insured without sufficient funds to repair their property.*"
The true effect of the *London* decision was that the court converted policyholders' actual cash value coverage into full replacement coverage for no additional premium. Notably, the *London* court did not make any attempt to reconcile the distinction between the two different types of coverage. If the *London* decision is permitted to stand, insureds with actual cash value coverage, who suffer total losses, could conceivably recover the full replacement value of their property while paying premiums based on actual cash value coverage. A possible result of this type of court decision is an overall increase in cost for basic property insurance coverage.
D. Contractual Time Limits on Replacement of Damaged Property
Generally, replacement cost coverage includes language that requires an insured to make a claim for replacement cost within a specified time period, usually 180 days after the loss. A typical replacement cost endorsement might provide, for example: *You may make a claim for loss or damage covered by this insurance on an actual value basis instead of on a replacement cost basis. In the event you elect to have loss or damage settled on an actual cash value basis, you may still make a claim for the additional coverage this Optional Coverage provides if you notify us with your intent to do so within 180 days after the loss or damage.*
Some insurers have unsuccessfully contended that to "make a claim" means to actually complete reconstruction or repair in the given time period. *Bourrie v. United States Fidelity & Guarantee Ins. Co.*, 75 Or. App. 241, 707 P.2d 60 (1985), is an example of one court's unwillingness to adopt this interpretation of the time limitation provision. The *Bourrie* court agreed with the insured that he was only required to notify the insurer of his intent to replace the building within 180 days of the loss and that he should be allowed a reasonable time to complete the reconstruction. See also, *Maine Mut. Fire Ins. Co. v. Watson*, 532 A.2d 682 (Me. 1987) (insurer must allow a reasonable time for reconstruction, if insured provided notice of claim within 180 days); *F.B. Ins. Co. v. Jones*, 864 S.W.2d 926 (Ky. App. 1993) (replacement cost available under homeowners policy so long as claim for replacement cost was asserted within 180 days of the loss; and the insured was not required to complete construction within that time period, but rather should be allowed a reasonable time to rebuild). Cf., *Hilley v. Allstate Ins. Co.*, 562 So.2d 184 (Ala. 1990) (insured's failure to satisfy the policy's condition precedent of notice of intent to reconstruct within 180 days precluded insureds from recovering full replacement costs for their fire damaged personal and real property). Thus, the majority of courts have interpreted replacement cost coverage time limitation language according to its plain and ordinary meaning. Since mere intent to replace property is insufficient to satisfy this condition precedent, policyholders who intend to seek full replacement cost coverage after a loss should provide their insurer with prompt written notice of their intention to replace their damaged property.
E. Quality Issues
1\. Materials of Like Kind and Quality
Replacement cost coverage can raise interesting yet challenging valuation issues when insureds opt to reconstruct their property after a loss. For example, an insured's home may have had simple single pane windows prior to a loss; however, the insured may choose to install more expensive triple insulated thermopane windows. Is the insurer obligated pursuant to a replacement cost coverage provision to pay the insured for this enhancement to the property? Some insurers have attempted to address this valuation issue by adopting policy language that provides: "*\[Insurer\] will pay the least of the following amounts: (c) The amount which it would cost to repair or replace that part of the building structure damaged or destroyed with material of like kind and quality less allowance for physical deterioration and depreciation.*"
Generally, courts have found that "like kind and quality" and "like construction" do not include differences in the new structure necessitated by law. See e.g., *Gouin v. Northwest National Ins. Co.*, 145 Wash. 199, 208-09, 259 P. 387 (1927); Cf., *Strait School Dist. v. RLI Ins. Co.*, 873 P.2d 1292 (Alaska 1994) (holding that "like kind and quality" does not mean built under the building standards of the original construction). As stated, some insureds will reconstruct damaged property with less expensive materials, while others might choose to reconstruct with better materials than existed in the original construction. Both of these options tend to undermine the intent of replacement cost coverage, which is to restore the insured to the same position they enjoyed prior to the loss. An insurer may require an insured to use the same or similar materials as in the original construction in order to prevent the insured from experiencing a windfall.
a. Replacement with Less Expensive Materials
Courts have reached different results when addressing the issue of whether to permit recovery of full replacement cost when insureds choose to reconstruct with cheaper materials than those used in the original construction. For example, in *Ambercrombie v. Allstate Ins. Co.*, 841 S.W.2d 838 (Mo. App. 1994), the insured's home was partially destroyed by fire. A dispute developed between the insured and the insurer as to the amount of the loss; therefore, the insured demanded an appraisal as provided for in her policy. The appraisers valued the loss at $52,621. Ambercrombie then hired a contractor to rebuild her home for the appraised amount, but she allowed for the substitution for cheaper materials and then applied the savings to add new features to her home. Upon learning of the change in the reconstruction plans, the insurer paid $36,970, or the actual cash value of the loss, since the insured had not restored the house to its pre-fire condition. The insured filed suit in an effort to recover the amount withheld for depreciation. The appellate court, reversing the trial court's grant of summary judgment in favor of the insurer, held that the insurer was not permitted to withhold payment for depreciation because Missouri statutory law required, in cases of partial losses, the insurer to either provide payment for the amount of the loss or repair the property. The court reasoned that by not challenging the appraisal, the insurer had elected to provide payment and could not holdback an amount for depreciation. Similarly, in *State Farm Fire & Casualty Co. v. Ponder*, 499 So.2d 1262 (Ala. 1985), the court allowed the insured to recover $74,430, the actual cash value of the home, despite the fact the insured had opted for replacement cost coverage and completed the repairs for $45,000.
A different result was reached in *Estes v. State Farm Fire & Cas. Co.*, 358 N.W.2d 123 (Minn. App. 1984), modified, 365 N.W.2d 769 (Minn. 1985), where the court held that a homeowner who repaired a slate roof with less expensive shingles was only entitled to recover the amount of actual expenditure and not the replacement value of the slate roof. Thus, the courts remain divided on this valuation of loss issue.
b. Replacement with More Expensive Materials
Somewhat consistent with those decisions prohibiting insureds from recovering full replacement costs when using cheaper materials, some courts have prohibited insureds from profiting from a loss by utilizing better materials. For example, in *Higgenbottom v. New Hampshire Indem. Co.*, 498 So.2d 1149 (La. App. 3d 1986), cert. denied, 501 So.2d 236, the court held that an insurer was not required to compensate an insured for the cost of replacing a roof with more expensive shingles than were used in the original construction; see also, *McCorkle v. State Farm Ins. Co.*, 221 Cal. App. 3d 610, 270 Cal. Rptr. 492, review den., (1990), (loss settlement claims requiring replacement with "equivalent construction" did not include additional costs which were mandated by a building code that required a wooden-floored garage to be replaced with a concrete floor). This issue often arises when changes in the local building code occur (see section c below).
Similarly, insureds will claim that improvements or repairs to "non-covered property" are necessary to effect repairs to "covered" property. See, *Roberts v. Allied Group Ins. Co.*, 79 Wash. App. 323, 901 P.2d 317 (1995) (holding insured could not recover for retaining wall used to shore up land surrounding fire damaged property).
Although courts have generally disallowed insureds from upgrading their properties after a loss by using better materials, the facts of a particular claim might in some instances allow such a recovery. See, *State Farm Fire & Casualty v. Ponder*, supra.
F. Location Restrictions
The drafters of replacement cost coverage originally sought to require insureds to rebuild on the same site after a loss. This requirement, designed to limit the "moral hazard" presented by replacement cost insurance, would prevent the insured from reaping a windfall by being able to replace a destroyed older building with a newer structure at an improved location. However, most courts have declined to enforce this condition precedent to coverage. As a result, there have been a number of decisions that permit an insured to recover replacement cost proceeds by simply rebuilding on a different site or, in the alternative, purchasing an existing structure at another location. See *Blanchette v. New York Mut. Ins. Co.*, 455 A.2d 426 (Me. 1982) (replacement at another location permissible); *Huggins v. Hanover Ins. Co.*, 423 So.2d 147 (Ala. 1982); *S and S Tobacco and Candy Co. v. Greater New York Mutual Ins. Co.*, 617 A.2d 1388 (Conn. 1992) (replacement on the same site was not required in order for an insured to recover under replacement cost provision of multi-peril policy; furthermore, erection of a larger warehouse at another location constituted a replacement); *Conway v. Farmers Home Mutual Ins. Co.*, 26 Cal. App. 4th 1185, 31 Cal. Rptr. 2d 883 (1994) (replacement of fire damaged home on same site not required for insured to recover replacement cost coverage, even though home repairable).
In *Kumar v. Travelers Ins. Co.*, 211 A.D. 2d 128, 627 N.W.S.2d 185 (1995), the appellate court affirmed a trial court decision that an insured is not required to rebuild on the same site. The *Kumar* court refused to interpret literally the policy's replacement cost endorsement's requirement that the insured repair or replace "on the same premises" in order to recover replacement costs. Rather, the court reasoned that this language merely served as a measure for limiting the amount recoverable to what it would cost to replace the structure on the same premises.
G. Effect of Code Changes
The effect of government code changes can also be found in a couple of situations different from those above. First, a building may sustain a partial loss and government regulations may require that the building be improved to code when repaired. The cost of this type of repair is greater than returning the building to its pre-loss condition. Second, there is the situation where a building is completely destroyed and the insured has a "replacement" insurance policy. Again, however, a change in building codes may make the replacement much more expensive than rebuilding to original specifications. In both of these situations, there is some question as to whether the insurer is responsible for the increased costs. A few recent cases have dealt with this issue, however, no general rule has emerged.
In 1995, a Washington appellate court decided a case involving a home destroyed by fire. In *Roberts v. Allied Group Ins. Co.*, the court focused on policy provisions to deny increased construction costs. The insurance contract provided that the insurer would "pay the cost of repair or replacement, but not exceeding the replacement cost of that part of the building damaged for like construction and the use on the same premises." The policy then defined replacement cost as "the cost, at the time of loss, to repair or replace the damaged property with new materials of like kind and quality, without deduction for depreciation." The court held that "'like kind and quality' and 'like construction' do not include differences in the new structure necessitated by law." The court distinguished a previous case that held the insurer should cover the increased cost of complying with building codes on the fact that the policy in the previous case did not contain the "like kind and quality" terms. Although the average person may believe that replacement cost would cover increased costs from building codes, the contract contained a provision limiting recovery to "like kind and quality." This exclusion denies recovery for improvements required by law. A Washington appellate court confirmed this rationale in the November 1996 case of *Dombrosky v. Farmers Ins. Co. of Washington*. In this case, the insured's home was damaged by fire and compliance with new building codes added additional costs to the repair. The insurer refused to pay the additional costs and the insureds filed suit. The court again relied on the policy provisions in deciding for the insurer. In this case, the policy limited recovery to the cost of "equivalent construction." The court held that this phrase had the same effect as "like kind and quality" and the expenses related to the new building codes were not covered.
The issue was also addressed recently by the Florida District Court of Appeal. In this case, Dade County sued the insurer of homeowners affected by Hurricane Andrew. The County required that many homeowners upgrade their damaged homes to comply with the building codes and elevate their homes to prevent flooding. The County sought a declaratory judgment that "replacement cost insurance" covered the code upgrades. State Farm claimed that these improvements were specifically excluded in its policies. The insurance contracts contained an "Ordinance or Law" clause excluding any increased costs incurred due to "enforcement of any ordinance or law regulating construction, repair, or demolition of a building or other structure…". The trial court granted summary judgment in favor of the County on the basis that the clause was ambiguous and it was interpreted to cover the increased costs. The appellate court, however, held that the clause was not ambiguous. The clause specifically provided that no coverage would be extended for increased costs due to enforcement of an ordinance or law regulating construction. "The exclusionary clauses are plain and unambiguous on their faces, allowing no room for interpretation." The summary judgment was reversed and judgment was rendered for the insurer. The additional costs were not covered by the policy.
The above three cases seem to follow the same rationale and may establish a general rule. However, there is case law on the other side of the issue. In a recent Alaska decision, the Supreme Court determined that the increased costs resulting from building code requirements should be covered, despite policy provisions to the contrary. In this case, a school building was destroyed by fire and additional costs would be incurred to rebuild the school to meet current building codes. The insurer paid the replacement cost but refused to pay the additional costs of code upgrades. The trial court granted a judgment on the pleadings for the insurer, basing the decision on the fact that the insurance policy contained clauses excluding loss "occasioned by a Civil Authority's enforcement of any ordinance or law regulating the reconstruction…"
The policy also contained clauses limiting the replacement cost to "the amount which it would cost to repair or replace the property with material of like kind and quality" and to the "replacement cost of the property or any part thereof identical with such property…".
On appeal, the insurer argued that these provisions were not ambiguous and specifically excluded the increased cost of code upgrades. The court, however, ruled in favor of the insureds in a somewhat convoluted decision. First, the Court determined that insurance contracts are contracts of adhesion and should be construed according to the principle of "reasonable expectations." The reasonable expectation of the school, according to the court, was that the replacement cost insurance would cover the increased costs. The court explained that the exclusion clauses were ambiguous and limited recovery to increased costs "occasioned" by Civil Authority's enforcement of an ordinance. Here, the loss was not occasioned by the ordinance, but by the fire. "In other words, the school district reads this group of exclusions to apply only when the loss is solely caused by enforcement of an ordinance and not where a covered event such as a fire triggers enforcement." As to the "like kind and quality clause," the court concluded that this clause does not come into play until "a fundamental and quantum difference in the nature of the building is sought to be made or when a totally new component is sought to be added to the building which was not present in its predecessor." The replacement building did not have to be a clone and a reasonable insured would expect the building to be replaced with the improvements. The court concluded that the increased costs of code upgrades are covered by the policies. The issue of coverage for code upgrades is an unsettled area of law. Insurers should attempt to draft policies to include exclusions that have been recognized by the courts. Additionally, an attempt should be made to make exclusionary language as specific as possible. This perusal of recent decisions in the area should provide a basic guideline. However, there are times when no amount of careful drafting can save the insurer from the co
H. Conclusion
There are no uniform rules concerning determining the actual cash value of property covered by insurance. However, general trends do show that three major tests have developed: Market value, replacement cost and the broad evidence rule. Also, the current trend seems to be toward the application of the broad evidence rule. Insurers and insureds should look to the decisions in their jurisdiction to determine the method courts use to determine value of specific items.
As to determining constructive total loss and coverage of code upgrades, again the courts are split. Although there is no way to assure an exclusion will apply, insurers should look to exclusions that have been upheld in drafting policy language. This area of the law is muddled, but careful policy drafting may eliminate some of the distinct laws.